Are You Taking Advantage of Tax Breaks for Rental Property Owners?
Are you getting ready for tax time? We know, we know… it’s not the most fun aspect of commercial real estate investment. But it is one of the most critical. You could be leaving significant amounts of money on the table if you are not taking advantage of all the tax deductions to which you may be entitled. Let’s take a look so you can tame tax time and maximize profitability.
Some key deductions that can help reduce your tax burden and/or net you a greater return on your investment:
This is a biggie! If you earn $25 million or less from your rentals, you can deduct mortgage interest payments on loans used to either purchase your property or improve it, as well as interest on credit cards for services/goods related to rental activities.
If you earn over $25 million from your rentals, your interest deductions are limited. There is a workaround though: you can agree to depreciate your property for 30 years instead of 27.5 years (more on this in a moment) and realize more significant interest deductions.
You can deduct the costs of purchasing and improving your rental property – but not all in the same year you bought or upgraded it. This is called depreciation. The IRS distributes the depreciation deduction across the useful life of the property (the standard used by the IRS is 27.5 years for buildings placed into service after 1986). So, you’ll get a deduction each year.
Let’s say you purchased a rental unit for $110,000. It was recently assessed at $90,000 (of this, $81,000 is for the house and $9000 is for the land). You can only depreciate the cost of the building. So you’d divide $81,000 by $90,000 to get the percentage that you can depreciate.
$81,000 ÷ $90,000 = 90%
Just a bit more math, we promise! You know the basis of the property, or your capital investment, ($110,000) and the value of the house ($81,000). The basis for the house is 90% of $110,000, or $99,000. So you can depreciate $99,000 over 27.5 years, or about $3600 each year. This is multiplied by your marginal tax rate to arrive at your specific deduction.
As mentioned above, if you earn over $25 million in rental units each year, you must agree to depreciate over 30 years instead of the standard 27.5. This lowers your deduction – but you can make up for it with the interest deductions.
Thank goodness for qualified accountants! This gets complex quickly!
You can deduct costs incurred when making repairs to your property. Whether you fixed plumbing leaks, replaced broken floor tiles, fixed the gutters, or patched holes in the drywall, the costs are fully deductible in the year they were completed.
Can you deduct costs related to improvements? What if you replaced a roof or renovated and modernized kitchens. These are considered improvements that increase the life of the property or increase its value. According to the IRS, they are “capital expenses.” They have a useful life of more than one year, meaning you need to capitalize them and depreciate the costs.
To do this, divide the cost of the improvement by its useful life. For example, if you’ve installed a new roof for $60,000 and it has a 30 year useful life, you can deduct $2000 per year ($60,000 ÷ 30 years).
This is just a start. There are a few more important tax deductions for rental property owners you should know about. Stay tuned for part two for more information!